Friday, March 22, 2013

My last post on Alliance Resources explored the differences between Alliance Resources (the best performing coal operation in North America) with Patriot Coal (famously and massively bankrupt).

Patriot produced only slightly less coal per worker (a key measure of cost-competitiveness) and it was higher quality coal.

Patriot had less debt.

They were about the same size - but alas - Patriot was bankrupt and so difficult to run they were closing mines in bankruptcy.

The differences lay in the balance sheet where Patriot had large post retirement benefit obligations and Alliance does not - and Patriot had large workers compensation obligations and Alliance does not.

The first one I understood. Patriot was heavily unionized. Alliance was not.

However the second one I did not understand. These were multi-mine operations in similar jurisdictions with similar numbers of employees. They both self-insure workers compensation. Unless one operation is massively safer than the other they should have similar workers compensation obligations.

I was puzzled.

So I went looking.

Here is the flows into and out of the workers compensation provision for the last full (non-bankrupt) year at the last 10-K for Patriot Coal...

December 31,

2011

2010

(Dollars in thousands)

Change in benefit obligation:

Beginning of year obligation

$

174,014

$

152,079

Service cost

7,496

9,258

Interest cost

9,492

8,963

Net change in actuarial gain

3,536

12,668

Benefit and administrative payments

(8,899

)

(8,954

)

Net obligation at end of year

185,639

174,014

Change in plan assets:

Fair value of plan assets at beginning of period

—

—

Employer contributions

8,899

8,954

Benefits paid

(8,899

)

(8,954

)

Fair value of plan assets at end of period

—

—

Obligation at end of period

$

185,639

$

174,014

Patriot Coal had $8.889 million in payments and an estimated total obligation of $185.6 million. The estimate of total obligation is 20.9 times current payments.

This compares with the last 10-K disclosure for Alliance Resources:

2012

2011

Beginning balance

$73,201.00

$67,687.00

Accruals

$24,812.00

$22,254.00

Payments

($10,477.00)

($11,235.00)

Interest accretion

$2,739.00

$3,174.00

Valuation gain

($13,229.00)

($8,679.00)

Ending balance

$77,046.00

$73,201.00

Payments were $10.48 million - a little higher than Patriot. However reserves were only 77.0 million. The estimate of total obligations is only 7.35 times.

If we were to reserve Alliance Resources on the same basis as Patriot we would have to add $141 million to reserves.

This difference has accumulated over time. If Alliance had used Patriots conservative reserving pre-tax earnings (and hence EBITDA) would be cumulatively $141 million lower than were actually recorded. This is clearly part of the reason why Alliance appears so profitable relative to the competition.

More importantly because Alliance is an MLP which distributes roughly its EBITDA, if a more conservative reserving had been used Alliance's distributions would cumulatively been about $140 million lower.

I wonder how the workers expecting to be paid compensation feel about having the money backing their compensation distributed to MLP unit holders?

In my crystal ball I see a class action.

John

Post script:

Dear Class Action lawyers - there is this little disclosure in the 10-K which might make any future class action more - well - rewarding. I will leave it to the unit holders, their lawyers and the general partner to interpret this:

Your liability as a limited partner may not be limited, and our unitholders may have to repay distributions or make additional contributions to us under certain circumstances.

As a limited partner in a partnership organized under Delaware law, you could be held liable for our obligations to the same extent as a general partner if you participate in the "control" of our business. Our general partners generally have unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to our general partners. Additionally, the limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in many jurisdictions.

Under certain circumstances, our unitholders may have to repay amounts wrongfully distributed to them. Under Delaware law, we may not make a distribution to our unitholders if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of the impermissible distribution, partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the partnership for the distribution amount. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.

7 comments:

This is an interesting conclusion, but have you compared your measure across other participants in the industry. Maybe 7 is the benchmark and Patriot had to overcompensate because of an unsafe work environment relative to other miners. I have not done the analysis, I was just curious (especially with your implicit conclusion that workers should file a class action suit)

You might want to mention that a key customer rescinded on Patriot's coal contract that were at significantly higher coal prices right before the bankruptcy. The total cost structure between both companies are not even comparable.

Alliance is definitely paying their distributions from debt borrowings but what MLP isn't? Production will increase with their new mines so they are probably just "pulling forward" this new source of cash flows for shareholders. What's really interesting is that the share count has remained flat for the last 5 year and leverage hasn't changed too much... this is unheard of for MLPs... must be some accounting trickery or perhaps this is a cash cow.

John - have you looked at Foresight Energy? They are not public but they filed an S-1 last year... probably ARLP's best peer as a pure play in the ILB. Capex is through the roof on Foresight though they don't break out difference between growth and maintenance.

John, why are you looking at annual reserve additions compared to total additions? It seems to me you should be looking at annual accruals for workers comp perhaps as compared to the number of employees or tons of coal mined. In theory, if Alliance has a younger employee base, or an employee base with less accumulated time working, Alliance should have a lower overall liability? Am I missing something?

Hi John. I have a somewhat general question I hope you are not too busy to answer. When it comes to a company like Alliance, which is not a complete fraud like some of the Chinese RTOs you have written about in the past, but you believe is "fudging" the numbers, what steps do you take other than writing about it on your blog? Assuming you become convinced that the financial statements are inaccurate, would the next step be to contact the audit committee or the company's accountants? Have you found the SEC to be interested in these type of cases? I think a lot of your readers would be interested in what follow up work is effective in exposing fraud, and what is typically a waste of time.

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